A Warning to All Mortgage Lenders in California and the Nation

Just like unwary homeowners trapped in unsuitable loans and an ever-increasing mountain of debt, many of our nation’s lenders are facing significant difficulties remaining afloat.

Recently California experienced the second-largest thrift failure in U.S. history—and potentially the most expensive to taxpayers. Last Friday federal regulators and the Federal Deposit Insurance Corporation shut down and took over Southern California based IndyMac bank, a lender with over $32 billion in assets that had specialized in risky mortgage loans. As a result of the foreclosure crisis, the bank essentially ran out of money to meet its obligations. The victimizers have now become the victims.

IndyMac preyed upon homeowners with poor credit and low documentation, and offered them riskier, higher-interest, non-traditional loans. Many of these loans were unsuitable to the consumers and IndyMac either knew or should have known the borrowers did not have the ability to repay the loans. Yet they continued to make these loans because mortgage laws were inadequate and regulators looked the other way. It doesn’t take a rocket scientist to figure out that when a lender gives lots of unsuitable loans to borrowers, guess what, the borrowers might default.

Nevertheless, IndyMac still had the chance to save itself when homeowners started defaulting and foreclosures started occurring. The lender could have placed a moratorium on foreclosures and then modified its mortgage loans so that the homeowner in crisis would still be able to remain in the home and continue to make a monthly payment. That way IndyMac would still have received a stream of capital. But because IndyMac felt compelled to extract every single last cent of profit from the homeowner, it failed to modify many of its home loans. As a result many more foreclosures than necessary occurred, and for each defaulted loan, the lender lost up to fifty percent of the loan value and a steady stream of payments.

Ironically it has taken the mass failure of IndyMac to result in our nation’s first mass moratorium on foreclosures. The FDIC and its well-respected Chairwoman, Sheila Bair, has now imposed a moratorium on foreclosures for all home loans currently held by IndyMac. The FDIC is also looking at placing a moratorium on loans serviced by IndyMac. In a recent interview on CNBC television, Ms. Bair made the commonsense observation that “Modified loans will be worth more than foreclosed loans.”

The central lesson learned from IndyMac’s failure is that lenders across California and the nation need to start aggressively modifying mortgage loans for struggling homeowners, lest they face the same fate as IndyMac. Rather than squeeze every last penny out of every single home loan, lenders should voluntarily impose a moratorium on foreclosures and work out loan modifications for those homeowners who can continue to make some form of reasonable monthly payment.

The CEOs and Boards of Directors of lenders need to wake up and smell the foreclosures. The industry-driven Hope Now Coalition has been widely documented as a failure when it comes to helping struggling homeowners modify their loans. Industry can no longer pass off window dressing as significant action.

What we need is a paradigm shift. Lenders need to stop going down the risky path of continuing to foreclose on homeowners (a lose/lose proposition) and start making many more loan modifications (a win/win proposition). We now know that we don’t even need to fire CEOs and Boards of Directors when they fail to act, or act too slowly—they will simply get taken over and booted by the FDIC.

By Ted W. Lieu, Chair, California State Assembly Rules Committee

Ted W. Lieu represents the 53rd Assembly District. Prior to being elevated to serve as Chair of the Assembly Rules Committee, he served as Chair of the Assembly Banking and Finance Committee. He is the author of several mortgage bills, all of which are currently pending before the California State Senate.

IndyMac played a risky game with people who have a bad credit rating and got greedy thinking that they could get money from high-risk people by giving them mortgages and giving them higher interest rates. This backfired on them as there is a reason their customers are high risk as they had problems paying their mortgages back.

Thank you for your comment. As you may know, over $4 billion of the state budget crisis comes from the foreclosure crisis.

Your suggestion that I and other members of the state legislature are not paying attention to the budget is factually wrong. Both the Assembly and Senate Democrats have put out a balanced budget proposal for this year and the years to come. We fully fund education and do not suspend Proposition 98, and we restore many of the Governor’s cuts to health care and social services. The Republicans currently have no budget proposal, although they do have a nice looking website.

The problem, which you may not be aware of, is that we need a two-thirds vote. This means we need Republicans to vote for the budget. So my advice to you is that you lobby Republicans because that is what is holding up the budget.

In addition, the risk of a bad budget that violates core Democratic values is far worse than a late budget.

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